Our current managed portfolio consists mostly of ETF's vs Mutual funds. An advisor from a different firm warned me about ETF's stating that they have risks. She sent me an example of a prospectus and highlighted three areas of concern: Authorized participant concentration risk, No guarantee of active trading market, and Trading issues. On the first one, she highlighted " The fund may have a limited number of financial institutions that act as participants none of which are obligated to engage in creation or redemption transactions. I truly do not understand what she is warning me about.
If you would be so kind to explain, I would be so grateful. I have tried to research this myself, but I am still confused.

Terry Says:

Well, this is a far-fetched worry for most, but not all, ETFs.  They are after-all, baskets of securities.  And if the market for some or all of those securities becomes illiquid, you might not get a “fair” price when you go to sell your ETF shares.  Further, those baskets are put together by “sponsors” — large investment management companies.  And in the case of a market disruption or illiquidity, it’s slightly possible that there may not be a way of getting more shares of the basket “put together” if you want to buy — or sold, if you (and many others) all want to sell at the same time.

In large, highly liquid ETFs this isn’t much of a worry — and won’t be until the world is falling apart!  At that point, you’ll have more than ETFs to worry about.  But with some smaller, less liquid, more limited concept ETFs this could turn into a problem if the stock market becomes volatile at some point.  Here’s an interesting article from the Wall Street Journal from a few years ago that explains this issue more fully.

Now, the question is whether this “advisor” from another firm is just giving you an education — or trying to get you to transfer your portfolio, sell the ETFs (giving him/her a nice commission) –and then reinvest in something else, also creating another commission?

Have a Question?

Ask yours!